What Is Cryptocurrency for Dummies | How Cryptocurrency Works?

Bitcoin, Ethereum, Litecoin, OmiseGo, NEO, GAS, and etc. They are all cryptocurrencies and you might have heard about them. So, is it too late to invest in Bitcoin, Ethereum or any other altcoins? The short and easy answer is no. However, you have to first know about cryptocurrency before you dive into it. If you are new to the world of cryptocurrency, this is an article outlining what exactly is cryptocurrency and how it works.

What Is Cryptocurrency for Dummies

A crypto-currency or cryptocurrency is an exchange medium just like money that can be used to pay for goods and services online. It can also be traded for physical cash. It works with the aid of cryptography. Cryptography, also known as cryptology, is the study and practice of methods for communication security where there are third parties referred to as adversaries. Cryptography is used in cryptocurrency for controlling the creation of more currency units as well as for transaction security.

Cryptocurrency is, therefore, a type of virtual or digital currency or in the simplest sense, money that can be used online only. Digital coins are stored in digital wallets and transferred digitally to other peoples’ digital wallets. No physical object ever exists.

There are currently many types of cryptocurrency online, with bitcoinbeing the first and arguably the most common type of cryptocurrency.

Definition: Cryptographic: Cryptocurrency uses a system of cryptography (AKA encryption) to control the creation of coins and to verify transactions.

Overview of Cryptocurrency

Cryptocurrency is decentralized and created collectively by the whole system of cryptocurrency based on a pre-specified rate, made publicly known at the time of creation. In physical economies such as those of countries, governments and corporate boards such as the Central Bank of the country control currency supply through its units for printing and asking for additions to banking ledgers digitally.

Governments or companies, however, have no ability to create new units of cryptocurrency. The anonymous nature of cryptocurrency transactions makes them well-suited for a host of nefarious activities, such as money laundering and tax evasion.

The decentralized cryptocurrencies technical system that is used to operate cryptocurrencies was first introduced by an individual or group known under the pseudonym, Satoshi Nakamoto.

Currently, more than one thousand specifications of cryptocurrency are in existence. Most of them are, however, derived from or similar to bitcoin, which is the first decentralized cryptocurrency that was fully implemented. The balance, integrity, and safety of the ledgers in the cryptocurrency systems are upheld by a community of parties that are mutually distrustful, known as miners.

The users also aid the validating and timestamp of transactions with their computer, including them in the ledger, based on a specific scheme of timestamping.

History of Cryptocurrency

In the past, a number of attempts have been made to make some form of digital money or electronic cash. Some of such attempts led to the creation of b-money by Wei Dai in 1998 and bit gold, shortly after by Nick Szabo.

Bitcoin was, however, created in 2009 and became the first cryptocurrency that was decentralized. The currency utilized SHA-256, a hash function that is cryptographic. In the process of trying to form a DNS that is decentralized and will make it very difficult to censor the internet, Namecoin was created in April 2011.

By October of the same year, Lifecoin was created. Even though few were successful, several cryptocurrencies have been created after including Peercoin.

How Cryptocurrency Works

A cryptocurrency such as bitcoin is made up of peer networks. All the peers have a full historical record of every transaction as well as the balance in all the accounts.

The transaction can be defined as a file that has information such as ‘James gives 15 Bitcoin to John’, with Bob’s private key serving as a signature.

The transaction is then shared to the network after it has been signed, with every other peer getting the information from the peer based on a simple peer to peer technology. Based on this, as soon as a transaction is completed, the full network becomes aware of it, almost instantly. It, however, gets confirmed on public ledgers within a particular time period.

The confirmation is a very important aspect of cryptocurrencies, as the confirmation is the major thing. This is because, prior to confirmation, it is possible for the transaction to be forged, since it is pending.

After confirmation, however, it can no longer be forged as it becomes a historical transaction record that is final. This is known as blockchain. Transactions can only be confirmed by miners. They are responsible for stamping the transaction and spreading them all over the network. The miners are paid with a token for stamping transactions.

In simpler terms, mining is the process of confirming transactions and adding them to a public ledger. In order to add a transaction to the ledger, the “miner” must solve an increasingly-complex computational problem (sort of like a mathematical puzzle)

Definition: Public ledgers – all confirmed transactions from the start of a cryptocurrency’s creation are stored in a public ledger. The identities of the coin owners are encrypted, and the system uses other cryptographic techniques to ensure the legitimacy of record keeping. The ledger ensures that corresponding “digital wallets” can calculate an accurate spendable balance.

Who Can Be a Miner?

It is possible for anybody to become a miner. Mining is open source, so anyone can confirm the transaction. The first “miner” to solve the puzzle adds a “block” of transactions to the ledger.

This is considering the network is not centralized and therefore, has no task delegation powers. However, there was the need for mechanisms to be put in place to avoid abuse by a ruling party. This is considering the fact that the system could instantly break if thousands of peers were created and forged transactions were distributed by a person.

Based on this, an individual can only qualify as a miner, if they invest some of their computers’ work. Basically, they will need to get a hash, which is a cryptographic function product that will link the new block to the former one. This is referred to as proof-of-work.

The proof-of-work can be defined as a protocol with a major objective of stopping cyber-attacks. This concept existed before the creation of cryptocurrencies but was used by Satoshi to prevent double spending and to verify a transaction’s legitimacy. It is further used for creating more digital currencies when miners are paid for their previous task.

Properties of a Cryptocurrency Transaction

A cryptocurrency transaction cannot be reversed once it has been confirmed.

This implies that nobody including Satoshi himself or your miner can reverse such a transaction. Once you have transferred the money, you have transferred it. It cannot be returned back to you. If a hacker steals your cryptocurrency or you transferred money to a scammer, then you have lost it. There is no way to get it back.

Cryptocurrency accounts and transactions are not connected to identities in the real world.

Bitcoins are gotten on so-called addresses that are about 30 characters of seemingly random chains. Even though the flow of transaction can be analyzed, it does not mean the person behind an account or transaction can be identified.

Transactions are very fast and international, implying that within a few minutes, it can be confirmed, irrespective of the physical distance between the sender and the recipient.

Only an individual who has the private key to cryptocurrency funds can send it, making the system secure. Big numbers and cryptography that strong make breaking the scheme impossible.

You do not require permission before you can make use of cryptocurrency. All you have to do is download the free software, after which, you will be able to receive or send bitcoins and other cryptocurrencies. There are no limitations or restrictions.

Should I Invest in Cryptocurrency?

The same question appeared back in 2015 and 2016. I bet another person will ask the same next year.

Go around and ask the people you normally interact with and see how much they know about Bitcoin or Ethereum or any other altcoin. I am willing to bet none of them know anything other than maybe a few close friends you normally talk to about cryptos.

Cryptocurrency is still relatively new to the world. Only a few countries accepted cryptocurrencies and there is many more coming.

The Philippines and Japan legalized Bitcoin and its businesses in their respective regions. Japan passed to accept Bitcoin as a legal payment method and two major Japanese retailers partnered with Japanese Bitcoin exchanges to start accepting the digital currency for payments.

Some of Japan’s largest retail giants including Bic Camera, which hold a massive influence over the Japanese technology and consumer markets, began to accept Bitcoin payments at their locations. Full article here.

How to Make Money With Cryptocurrency?

Buy and Hold

Let’s take bitcoin, for example, the price of bitcoin has steadily been increasing since its inception. The price is up over 100% in just the last year. That’s a pretty good profit. There was a Norwegian man (Guardian UK article reported in 2013) who bought $27 of bitcoins in 2009 and they’re now worth more than 1 million.

Some analysts have predicted that Bitcoin will exceed $10,000 one day. In part because governments, corporations are now using and learning from the blockchain technology to create secure data, payment, systems, the effect on the industry, business, finance. The Blockchain technology is here to stay and being adopted by the big organizations with a lot of money- for example, it is being used by Goldman Sachs, Barclays Bank, the Estonian government, Microsoft amongst many other places. Venture capital firms are plowing money into Blockchain and Bitcoin startups.

Cryptocurrency Trading

This is becoming very popular especially as bitcoin makes new headlines each time it hits a new all-time high. The most popular exchange is CEX.IO. Probably the most attractive way out of them here, there’s great profit to be made here as well. If you can read charts or anticipate price movements or both BTC and Alts, you can make money. Margin Trading ups the risk/reward factor even more.

I know people that do both. You could do a mixture of both, e.g. keep 75% held in a wallet, and 25% used to trade.

Summary

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What Is Cryptocurrency for Dummies | How Cryptocurrency Works?

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Learn about cryptocurrency before you invest. If you are new to the world of cryptocurrency, find out what is cryptocurrency and how it works for dummies.

Alex is the owner of Managing Your Finance. He helps newbies start their own online businesses. Sign up for his 7-Day Free training course and learn how to start making a sustainable income online and quit your 9-to-5 job.